Principal transactions between an adviser and a client

The adviser’s role changes the conflict. In an ordinary agency trade, the adviser arranges a purchase or sale for the client. In a principal trade, the adviser is the counterparty using its own account. The adviser may have an economic interest in the price or in completing the trade, so the client must know who is on the other side before deciding whether to proceed.

Recognize the principal capacity

Section 206(3) of the Investment Advisers Act applies when an adviser, acting as principal for its own account, knowingly sells a security to or purchases one from a client. The relevant question is not what the firm calls the trade but whose account is the counterparty. A transaction routed through an affiliate may also be treated as the adviser’s transaction under applicable rules.

Disclosure and consent

Before the transaction is completed, the adviser generally must disclose in writing the capacity in which it is acting and obtain the client’s consent. The client should be able to understand that the adviser is trading against the client, not merely placing an order with an unaffiliated market participant. Consent is tied to the conflict and does not eliminate the adviser’s other fiduciary duties.

Do not confuse principal and agency-cross trades

An agency-cross transaction involves the adviser acting as broker for both the advisory client and the other party. It is not the same as the adviser trading from its own inventory. Separate rules may permit an adviser to rely on prospective consent for qualifying agency-cross transactions if specific conditions are met. Do not import that exception into every principal transaction; identify the adviser’s capacity first and apply the rule for that structure.

A planner’s review points

• Identify whether the adviser or an affiliate is a principal in the trade.
• Confirm that written disclosure identifies the adviser’s capacity.
• Check that consent is obtained within the legally permitted timing.
• Consider price fairness, best execution, conflicts, and the client’s interests separately.
• Keep the required disclosure and consent record in the client file.

Classify the transaction before executing

A principal transaction occurs when an adviser acting for its own account knowingly buys a security from or sells a security to a client. It is different from an agency cross, where the adviser arranges a trade between advisory clients or between a client and another party while acting as broker or agent. Capacity determines which disclosure and consent rule applies.

Section 206(3) requires written disclosure of the adviser’s capacity before completion and client consent before completion. The SEC interprets completion as settlement, so consent may occur after execution but before settlement if the client has enough information to make an informed decision and can refuse before the transaction completes. The article should not imply that the SEC rule always requires consent before trade execution.

A blanket clause in an advisory agreement may not replace transaction-specific disclosure and consent. The client needs to know the adviser is acting as principal, understand the material conflict, and receive enough information about the proposed transaction to decide. The adviser should preserve the disclosure, consent, security, price information, and timing in its records.

Do not confuse principal transactions with routine broker compensation, a sale of a security by an unaffiliated third party, or an agency cross. Other fiduciary disclosure duties can apply even when §206(3) does not. A transaction can be technically disclosed yet still violate the broader duty of loyalty if material conflicts are hidden or the client is misled.

In an exam scenario, identify who owns the security, the adviser’s capacity, the transaction direction, and whether the client is retail or institutional. Then state written capacity disclosure and consent before completion/settlement. Check any applicable exception or rule for the exact transaction and adviser.

The planner should escalate a proposed related-party trade to the compliance department and avoid recommending it solely because the adviser benefits. Compare alternatives and document why the trade serves the client’s interest.

Key takeaway

A principal trade puts the adviser on the other side of the client’s transaction. Written disclosure and client consent address that specific conflict; they do not waive the adviser’s broader obligations.